A broader and more theoretical objection to price caps is that they create deadweight for society. It is an economic deficit caused by an inefficient allocation of resources that disrupts the balance of a market and contributes to making it less efficient. A price cap leads to a shortage if the legal price is lower than the market clearing price, but has no effect on the quantity delivered if the legal price is higher than the market price. A price cap below the market price leads to a shortage that leads consumers to compete vigorously for limited supply, which is limited because the quantity supplied decreases with price. The laws that the government enacts to regulate prices are called price controls. Price control comes in two versions. A ceiling price prevents a price from exceeding a certain level (the „ceiling“), while a floor price prevents a price from falling below a certain level (the „floor“). First, let`s use the supply and demand framework to analyze price caps. It`s easy to look at the totals and show that the market surplus has declined, but how does this change affect individual consumers and businesses? The price cap is prompting landlords to reconsider staying in the rental market, as fewer landlords can benefit from lower prices.
As a result, 100 owners leave the market and reduce their production surplus to zero. This lost surplus is $10,000 and is represented by Zone C in Figure 4.5c. Everyone needs affordable housing. Perhaps a change in taste makes a particular suburb or city a more popular place to live. Perhaps local businesses will expand, bringing higher revenues and more people to the area. Changes like this can lead to a change in the demand for rental housing. The interactive graphic below (Figure 1) explains how this is done. The most effective way to implement maximum prices would also be to try to process supply. If housing is too expensive, a long-term solution is to build more affordable housing – not just rely on the highest prices.
A price cap is the prescribed maximum amount a seller can charge for a product or service. Usually set by law, price caps are usually applied to staple foods such as food and energy products when these products become prohibitive for ordinary consumers. This has been a rather lengthy explanation of price caps, but it will fuel the discussion on the whole policy. Any policy we look at in microeconomics has both a volume effect and a price effect, and it`s important to understand how politics affects individual market participants. This is because the marginal propensity to consume increases with lower incomes. By raising the wages of low-income workers, they will spend their increased disposable income to live, thereby stimulating the economy. As the increase in technology makes each worker more productive, the price of labor becomes a smaller part of the cost of goods and services, so a higher minimum wage will increase very little, if at all. Therefore, the increase in aggregate demand caused by the increase in the minimum wage, while minimizing the increase in the prices of products and services produced by these workers through technology, will more than offset any negative microeconomic effect of rising wages. Moreover, according to efficiency wage theory, higher-paying workers will work harder and be more productive, thereby increasing output for businesses and the economy. And a higher minimum wage will increase the labour force participation rate, thereby increasing the overall economic prosperity of the economy! Rent control is a common type of price cap that large municipalities like New York City often impose to make housing more affordable for low-income renters. In the short term, housing supply is inelastic, as the number of buildings already delivered is constant and buildings under construction continue due to sunk costs. The so-called economic relief through controlled gas prices was also offset by new spending.
Some petrol stations have tried to compensate for the loss of revenue by mandating previously optional services such as windshield washing as part of refuelling and billing. When prices are set by a free market, there is a balance between supply and demand. The quantity delivered at the market price corresponds to the quantity requested at that price. The introduction of price controls by the government therefore leads to either oversupply or overdemand, as the legal price often differs considerably from the market price. In fact, the government imposes price controls to solve a problem caused by the market price. For example, a rent brake is imposed to make rent more affordable for tenants. This, of course, leads to new problems, such as a decline in new housing construction, but governments often do not consider the future. Since politicians have limited mandates, they are more inclined to solve current problems and not worry too much about future problems. As they say, politicians like to kick the street, which leads to future problems.
But avoiding future problems doesn`t help politicians get re-elected. Price controls are therefore a political opportunism to solve current social problems, which will find support, at least temporarily, for politicians who deal with the problem, even if price controls are often harmful to the economy in the long run. While price caps are intended to ensure access to the most important goods, they can sometimes have the counterintuitive effect of making those goods less accessible. Indeed, the price imposed by the government does not reflect the market forces of supply and demand.